December 2007, part 3; It’s lonely at the top
Read the previous two posts first. Here’s Bernanke’s policy recommendation, in its entirety:
CHAIRMAN BERNANKE. Thank you. Well, again, thank you, thank you all. I do think we need to move today. Once we take into account the drag from financial conditions, arguably the current rate is neutral or even somewhat restrictive. For example, the Taylor rules in the Bluebook have the neutral rate between 4 and 41â„4 percent. Moreover, there has been quite a market change. Whether you look at markets or look at simulations, the FRB/US equilibrium real funds rate, for example, is down 70 basis points since the last meeting, which of course is just a summary of the revision of the forecast. On the other hand, you get similar numbers when you look at actual market indicators. So I think there is a sense in which our policies become de facto more restrictive and need to be addressed. On top of that, there is some case for insurance, although the discussion around the table illustrates that that is a complex idea when you, in fact, have a dual mandate and there are risks in both directions.
If the choice were between 0 and 50 basis points, I would be very tempted to do 50 basis points. I think it would move us more toward accommodation, and it would be very pleasant to get the same kind of market response we got after September in terms of improved functioning and credit extension. That said, I think there are some risks to going with 50 basis points. I acknowledge what others have said, which is that it is not just about the rate but also about what the message is. In particular the markets already expect us to ease quite a bit more. We are not pushing strongly back against it with 25 basis points. If we do 50, we may be saying to the market that we are willing to do even more than you currently expect. I think that poses some risks to inflation expectations and poses some risks to the dollar, which is a little fragile right now. You can imagine it even having reverse effects with respect to the economy””for example, if it caused oil prices to jump or if it caused nominal interest rates to rise, thereby raising nominal mortgage rates. The other concern I have is that, for better or worse, given our communications and market expectations, at this point a 50 basis point cut would be viewed as something of a lurch and might signal, as others have suggested, more concern or private information about the economy that we in fact don’t necessarily have. You can tell that I am quite conflicted about it, and I think there is a good chance that we may have to move further at subsequent meetings. In that respect, it is very important that both in our statement and in our intermeeting communications that we signal our flexibility, our nimbleness: We are not locked in, we are responsive to conditions on both sides of the mandate, and we are alert to new developments.
With all of that in mind””and although I don’t think the TAF is really a significant substitute for monetary policy, on the margin I think it is helpful””I recommend 25 basis points and alternative B. I did not hear much support for a downside risks sentence, and I agree that adding it would probably not very substantially affect the signal that we are sending today. So that is my proposal. Any comments? If not, could you please call the roll?
After the extravagant praise I gave Mishkin, you might expect me to trash Bernanke’s policy recommendation. In fact, it doesn’t do much for me either way. If you look at the bolded sections it’s clear that Bernanke understands Mishkin’s comments, and indeed I’d guess if you asked him in private he would have told you that Mishkin made the bast case of anyone in the room. But in the end Bernanke opted for 25 basis points. Why?
1. Perhaps he had more concern about inflation than Mishkin did.
2. Maybe he knew he didn’t have the votes, and wanted to be in the majority. Perhaps he had not had time to round up enough support, as conditions deteriorated quite rapidly right before the meeting. He didn’t want to be in the minority; a very awkward position for the Chairman.
3. And along with option 2, he probably thought there was still time to do further cuts, if it became obvious that the Fed had erred.
Was it too late after this fateful vote? I don’t think so, RGDP rose at late as the second quarter of 2008. Aggressive easing in 2008 certainly could have prevented a severe recession. On the other hand I think there was some permanent damage done. Mishkin was right that it was important that market understood that the Fed would do whatever it takes to prevent a big drop in NGDP. The December 11, 2007 decision made markets a bit less confident on that point, which would come back to haunt the Fed in late 2008.
Come back here next year for my analysis of the 2008 transcripts—that’s when things will really get interesting.
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5. February 2013 at 19:27
I guess I don’t follow what he’s saying. The market expects the Fed to cut the rate somewhere between 25 and 50 bps, so 50 would be more than expected. OK. Isn’t that the point? If you do what’s expected, it’s what’s expected, so current asset market conditions indicate what will happen if you do what’s expected. And he’s worried about current asset market conditions, so presumably doing more than expected is the point. And by the same token, 25 bps is less than the market is expecting, so presumably that would make asset market conditions worse. So there’s an inflation worry, but he’s looking at the financial markets for the real economy’s response (correctly), but looking at reported inflation for inflation’s response? Why not look at the TIPS? And if he does he’ll see inflation expectations aren’t collapsing, but they’re leaving plenty of room to err on the side of easing. So this seems confused to me–either look forwards or look backwards, but not both.
5. February 2013 at 19:44
Why is it, in a democracy, we have to wait five years to find out how people are deciding our financial and economic fates?
Is this good governance?
Has it led to better decision-making?
Does it help markets with guidance, comfort, clarity?
Is it transparent? Is there accountability?
It seems be many measures, the FOMC (Rube Goldberg comes to mind, btw) fails as an institution in a modern democracy, by results, by process and by appearance.
And—and this is an important “and”—were the FOMC meetings televised, say on CSPAN, there would have been a much greater opportunity of the Scott Sumner’s of the world to weigh in, to effectively give advice through blogging.
Morever, I am beginning to think the make-up of the FOMC is far from what it should be.
Are there any people from the housing, manufacturing, agriculture industries? And labor reps? Trucking guys? Oh—people who work and live in the economy, and need their jobs for their daily bread? Oh, those people. People who might say, “Sheesh, I can live with 5 percent inflation for a few years if it means we all have jobs. Right now it is miserable.”
The more I ponder this, the more I think the Fed should be placed into the Treasury Department, and the Fed chief appointed by the U.S. President to serve a four-year term coterminous with the U.S. President.
This current arrangement is just silly.
Tell me how great the current arrangement is working out. Tell me about the Great Depression of 2008 and Richard Fisher.
Right now, the public has no idea who to hold responsible for monetary policy.
Is that good governance?
5. February 2013 at 19:52
‘2. Maybe he knew he didn’t have the votes, and wanted to be in the majority. Perhaps he had not had time to round up enough support, as conditions deteriorated quite rapidly right before the meeting. He didn’t want to be in the minority; a very awkward position for the Chairman.’
I think the above is most likely. It hadn’t been all that much earlier that Milton Friedman had said that it looked as though The Fed had ‘found its sweet spot’, so why rock the boat.
5. February 2013 at 19:52
The grading committee give Bernanke a “C+” for his mid-term exam in “Monetary Policy in Practice.”
In particular, severe deductions were incurred for the following:
“for example, if it caused oil prices to jump or if it caused nominal interest rates to rise”
Does Bernanke believe in the fallacy that higher interest rates equal tighter money?
“at this point a 50 basis point cut would be viewed as something of a lurch and might signal, as others have suggested, more concern or private information about the economy that we in fact don’t necessarily have.”
Does Bernanke also believe in the fallacy that the Fed should engage in false displays of confidence?
Bernanke receives positive credit for correctly acknowledging “our policies become de facto more restrictive”.
Bernanke also receives credit for a minimal understanding of the course material, and a “+” for playing well with others.
Overall, Bernanke could qualify for a “B-” but the grading committee is intent on reducing expectations of grade inflation.
Therefore, Bernanke receives a “C+” for his 2007 mid-term examination.
6. February 2013 at 03:32
Benjamin Cole: With regards to your idea of having more non-economists in the room…If firefighters are putting out a fire in your house, do you want to rush in and help them? If doctors are determining your diagnosis and trying to figure out the best treatment, do you want them to ask you what you think is wrong? No, because you wouldn’t know what you are doing. Yes, truckers matter, but that doesn’t mean they know how to achieve their goals. Moreover, one trucker is hardly representative of the common people who would ALL say I want 5% inflation if it means I get a job (indeed, that you say that shows how unrepresentative one person is because many people would say 5% inflation is unacceptable no matter what).
The idea that economists like Bernanke and Krugman are just sitting in their fancy offices and don’t understand the simplicity of common-people economics just demonstrates why non-economists should not design policy. Economics is complicated and sometimes counter-intuitive. The recession would have been a lot worse if average Joes were dictating policy based on their gut feelings about how the economy ‘should’ work.
6. February 2013 at 05:05
I have to admit, reading Fed transcripts reminds me of Alice in Wonderland way more than I like. I’m actually surprised by the offhand comment Bernanke made about dollar strength and oil prices. Why does the exchange rate matter in an inflation targeting regime?
6. February 2013 at 05:22
Scott:
Imagine to scenarios:
1. A committee selects a chair. The chair is responsible to the committee. In the extreme, the chair can be deposed by majority vote at any time.
2. Some outside authority (the voters, the President, etc.) appoints a chair. The Chair is responsible to that outside authority with the mission of leading the committee.
I think the Chairman of the Federal Reserve is in situation 2. Your argument that the Chair should not vote in the minority suggests that the Chairman of the Federal Reserve is in situation 1.
I serve as Chairman of Town Council. Town Council did not elect me. The voters elected me. We have a Mayor/Council form of government. One of my duties is to Chair Town Council meetings, and I vote on all items. I never assume that I must be in the majority.
There is another form of government in South Carolina called Council/Mayor. In that form of government, Council elects one of the members of Council to serve as Mayor. The Mayor is the presiding officer of Town Council. Perhaps it would be awkward for such a Mayor to vote differently than the majority that selected him (or her.)
I have been on many committees at school. I have chaired some too. The chair is always selected by the members of the committee.
Are you (and Bernanke) treating the FOMC like a Faculty committee?
At The Citadel, the Military College of South Carolina, Department Chairmen are apppointed by the Provost (or maybe the President, at the recomendation of the Provost.) The Chair is supposed to lead the Department. (Provosts who choose Chairmen that the Department dislikes are despised, of course, and Department Chairmen that are fighting with their departments all the time are not considered effective by the Provost. Still, just reflecting the majority will of the Department is not the job description.)
I understand that the usual practice in most universities is for Departments to elect Chairmen. Is that Bernanke’s perspective? Is it yours?
6. February 2013 at 05:32
The FOMC is not a council of economists, though I do think there have been more economists there over time (as opposed to bankers.)
Noneconomists have sometimes had crazy views, like high interest rates cause inflation by increasing costs.
On the other hand, putting an economist on the Fed who really believes that the quantity of money should be fixed, or perhaps managed, so the deflation rate is equal to the real equilibrium interest rate, and that further, prices and wages always adjust as in an auction market so that real expenditure always equals potential output–that’s how my models are put togetner is worse than having an average person on the FOMC.
Or what about an economist who believes that the central bank should set interest rates with a mind for the functional distribution of income between labor and capital, and it is up to the politicians in the legislature to manage taxes and government spending to maintain full employment while using price and wage controls to control inflation?
Or what about an economist who believes that inflation depends on cost push factors and that monetary policy can impact real expenditures to keep real output at a high level?
Or economists who believe that there is a long run trade off between inflation and unemployment and that “social welfare” requires a high inflation rate?
Or economists believe that velocity has a long run constant trend level and that any apparent deviation will be reversed, “soon enough” so that a stable growth path of M2 is best?
6. February 2013 at 05:56
Bill, I agree that the chair should be willing to dissent. My point was that this is not the tradition at the Fed. So it may explain his behavior.
I agree with most of the other comments posted here.
6. February 2013 at 05:58
Wasn’t the damage really done by this time? Wasn’t the underlying problem a housing bubble? By late 2007, this was baked in, and I have difficulty seeing how accommodative policy could have prevented a re-alignment of housing prices with rents and incomes without some sort of unpleasant correction. I mean, I remember sitting with my mother at the kitchen table and looking at the swelling of the Case-Shiller index: “We’ll, that’s going to end badly,” I commented. That was in 2006.
So how does your notion of accommodative policy prevent the necessary correction of housing prices in a reasonable amount of time–keeping in mind that it took six years even with a sharp recession.
6. February 2013 at 05:58
Wasn’t the damage really done by this time? Wasn’t the underlying problem a housing bubble? By late 2007, this was baked in, and I have difficulty seeing how accommodative policy could have prevented a re-alignment of housing prices with rents and incomes without some sort of unpleasant correction. I mean, I remember sitting with my mother at the kitchen table and looking at the swelling of the Case-Shiller index: “We’ll, that’s going to end badly,” I commented. That was in 2006.
So how does your notion of accommodative policy prevent the necessary correction of housing prices in a reasonable amount of time–keeping in mind that it took six years even with a sharp recession.
6. February 2013 at 06:42
No wonder these guys started doing press conferences. In transcript form (when the FOMC members are able to use English!) it’s very clear what they want to do. Yet it seems that they waste a lot of energy trying to squeeze that message into an appropriate number: 0.25 or 0.50. If expectations management is important, then they should use English more often.
6. February 2013 at 09:02
I think it would have been interesting if they could have calibrated the easing to 30 bps. It would give the idea that while we are not panicking we are willing to do more than the minimum. Because of the tradition of using quarter percent changes and obfuscation of guidance language many people may be unable to figure out whether the fed is asleep at the wheel when they choose the lowest possible increment.
In the end as far as I can tell South Park has it right and they choose policy based on headless chickens running around.
6. February 2013 at 09:30
@Steven Kopits: “I have difficulty seeing how accommodative policy could have prevented a re-alignment of housing prices”
That isn’t the important issue. The issue is whether a housing “correction” needs to infect the rest of the huge and diversified US (and global) economy. There was a huge stock market crash in 1987; the US economy as a whole barely noticed. There was a large dot-com crash in 2000; again, the macro economy barely noticed.
Housing could have corrected by going flat, like in Australia. It didn’t need to plunge. And, regardless of whatever happened in housing, there is no reason that schoolteachers needed to get laid off in 2008. The transmission mechanism from housing to schoolteachers was an unnecessary fall in aggregate demand (NGDP), which is fully under the control of the Fed.
6. February 2013 at 10:22
Why does the change have to be in increments of 25 basis points? If they think 50 is too much and 25 isn’t quite enough, why not do 30 or 40? Or 37.5? The stock market moved off fractions years ago because everything is on computers that can calculate to as many significant digits as necessary.
6. February 2013 at 10:30
Dennis,
25 basis point cuts was a Greenspan creation. In the olden days 50 bps was the minimum.
6. February 2013 at 16:09
There is at least one oddity in there. When Bernanke says that a 50 basis point cut might lead to an increase in mortgage rates, he’s kind of implying that that would be a bad thing. But if mortgage rates increase due to higher loan demand (because home buyers now expect a higher path for NGDP and house prices), that’s not a bad outcome at all.
7. February 2013 at 05:45
Steven, A housing construction correction was inevitable, and indeed was largely over by early 2008. But unemployment was still 4.9% in April 2008. I am talking about the severe recession of late 2008, which was not caused by the housing recession. It was caused by tight money.
errorr and Dennis, That’s a good point—does anyone know why they move in 1/4% increments?
Jeff, I agree.
12. February 2013 at 10:03
“errorr and Dennis, That’s a good point””does anyone know why they move in 1/4% increments?”
My guess: If they did it in 1/5 or 1/8 increments, it would show more of how silly it is for them to control interest rates like that in the first place?
It would be like “Chocolate rations have increased by 0.005% this week”. It’s tragifunny.
14. June 2013 at 13:15
[…] even more peculiar given that there were already serious concerns about economic distress in late 2007. As, the decision to wait three months to lower interest rates to zero was a conscious one, and one […]
23. June 2013 at 13:17
[…] even more peculiar given that there were already serious concerns about economic distress in late 2007. As, the decision to wait three months to lower interest rates to zero was a conscious one, and one […]